The United Arab Emirates (UAE) has signed the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (Multilateral Instrument or MLI).
Earlier this year, the UAE was removed from the European Union's list of non-cooperative jurisdictions for tax purposes. The signing of the MLI by the UAE on June 27, 2018 will reinforce its position as a cooperative and transparent jurisdiction.
UAE's positions on MLI
Currently, there are 83 double tax treaties in force between the UAE and other jurisdictions and more than 30 in various stages of negotiation, ratification, etc. Under the MLI, the UAE has notified that all of these tax treaties will be covered by the MLI which means that the application of these tax treaties will potentially be altered by the provisions of the MLI which constitute minimum standards under the OECD Base Erosion and Profit Shifting (BEPS) Action Plan. These minimum standards include, among others, the Principal Purpose Test (PPT) and the Mutual Agreement Procedure (MAP).
In general, the PPT rule denies a tax treaty benefit to a taxpayer where one of the principal purposes for entering into a transaction or arrangement was to obtain that benefit. As a quick illustration, ACo, a company tax resident in Country A, wholly owns an operating subsidiary, CCo in Country C. Subsequently, ACo interposes a holding company, BCo in country B solely with a view to benefitting from the more favourable treatment under the B-C tax treaty (for example, an increased reduction of withholding tax on dividend distributions). The interposition of BCo is very likely to be challenged by Country C's tax authorities under the PPT rule. For the rule to apply, the obtaining of a tax benefit need not be the sole or main or dominant purpose of the arrangement or transaction in question. On the other hand, the MAP provision will facilitate resolution of cases of double taxation as well as a proper and correct interpretation and application of the provisions of a bilateral tax treaty by allowing taxpayers to approach the competent authorities of both states for that purpose.
Although, in theory, the UAE has the option to sign up to other anti-tax avoidance provisions in the MLI, the UAE has not chosen to do so. Unlike the BEPS minimum standards, which apply automatically, the optional provisions can alter an existing tax treaty only where such provisions apply symmetrically. Measures dealing with hybrid entities, dual resident entities, methods for eliminating double taxation, dividend transfers transactions, capital gains from the alienation of immovable property entities and various measures intended to counter avoidance of permanent establishments are not expected to affect any of the UAE's covered tax agreements. In addition, the UAE has not chosen to adopt the mandatory arbitration provision in the MLI.
The effect of the UAE having signed the MLI is that its tax treaty network will be updated to include the BEPS minimum standards in respect of the PPT and the MAP provisions. The granting of tax treaty benefits will be subject to the satisfaction of the PPT in addition to the other (already existing) treaty requirements of "residence" and "beneficial ownership." Since the UAE does not currently levy corporate income tax (except for some specific industries), it is unlikely that the PPT will be invoked by the UAE tax authorities. Subsequent to the MLI taking effect for the UAE and its tax treaty partners, the PPT can be invoked by the tax authorities of a treaty partner country to scrutinize a transaction or arrangement for treaty abuse.
Historically, the UAE has been used by non-resident investors and businesses not only as the destination country of their investments and business operations but also to structure their investments into the wider region. The impact of the new rules will very likely be felt in the latter set of cases where a treaty partner country is the state of the source of income. Where tax treaty benefits are denied and the higher tax costs cannot be used effectively as foreign tax credits in the home country of the taxpayer, they will end up becoming a permanent tax cost for that taxpayer.
The adoption and use of the PPT rule is likely to encourage centralization of activities, in one place or a few places globally by businesses, for example in the form of global or regional investment platforms. Centralization and the related concentration of substance will be instrumental for demonstrating commercial reasons and economic substance for a structure to counter another country's tax authorities' challenge under the PPT rule. Businesses will naturally be inclined to consider, for this purpose, jurisdictions which have the necessary legal environment and the appropriate infrastructure in this regard. Because the UAE has an ideal infrastructure, including an extensive tax treaty network, to accommodate the creation of such regional (eg, Middle Eastern, African and Asian) platforms, it would be advantageous for businesses and investors to consider a UAE platform for their multinational operations and investments.
Taxpayers may wish to consider revisiting and reviewing their existing investment and legal structures to determine if and to what extent the newly introduced anti-treaty shopping rules will impact those structures. This assessment should be followed, where necessary, by steps to revamp (or even overhaul) existing structures so as to mitigate the (adverse) impact of those rules. In addition, taxpayers considering to make investments out of or through the UAE should take these new anti-treaty shopping rules into account to ensure that the structures being put in place will withstand the scrutiny of the PPT rule.
Under the improved MAP, taxpayers may be able to access the assistance of competent authorities to resolve any dispute resulting in taxation not in accordance with any of the 114 covered tax agreements, as well as to resolve any treaty interpretation questions. With the commitment reflected in the MLI and pressures that are likely to be put on countries through the OECD's peer review process, we are hopeful that MAP will become a more effective tool for resolving cross border tax disputes.
If you need more information about this development and about tax concerns in the UAE, please contact one of the authors.